Lean Posts

I watched most of the Startup Lessons Learned Conference from home. Thanks to the magic of justin.tv, I also brushed my teeth, had breakfast, cleaned the bathrooms, and did a couple phone calls at the same time. Here are my two favorite talks from the conference.

I think this is going to be the most actionable startup conference ever and the lead organizer, Eric Ries, has given us a whopping 25% discount for Venture Hacks readers who use the discount code VENTUREHACKS. (If you’re not in the Bay Area, check out the simulcasts.)

The list of speakers and mentors at the conference is off the hook. And we’ve interviewed Eric Ries many many times:

My lean journey

I first learned about lean software development when my brother Farb closed a Series A for Grockit with Benchmark. He was looking for developers and I told him to check out my del.icio.us bookmarks for developers and designers. He went through my bookmarks and hired Pivotal Labs, a team of contract developers that follows a rigorous Extreme Programming process (Farb has hired his own team since then.)

Fast forward a couple years and Farb turned me on to Pivotal for a project I was working on. I hired them and got hooked on Extreme Programming. I started learning more about lean and eventually wrote a half-wrong post called Lean startups find their moment. Fortunately, Eric Ries was already blogging about lean startups, saw my post, and corrected my errors in Lean startups vs. lean companies.

Now, Eric has roped Farb in to speak at the conference:

(The video also seems to imply that Farb is auditioning for the cast of CSI.)

This guest post is by Ash Maurya, a lean entrepreneur who runs a bootstrapped startup called CloudFire. If you like it, check out Ash’s blog and his tweets @ashmaurya. – Nivi

What you charge for your product is simultaneously one of the most complicated and most important things to get right. Not only does your pricing model keep you in business, it also signals your branding and positioning. And it’s harder to iterate on pricing than other elements of your business. Once you set a price, coming down is usually easier than going up.

Should I charge for my MVP?

Most people choose to defer the “pricing question” because they don’t think they (or the product) are ready. Something I hear a lot is that a minimum viable product is by definition (embarrassingly) minimal. How can you possibly charge for it?

A minimal product is not synonymous with a half-baked or buggy product. If you’ve followed a customer development process, your MVP should address the top 3 problems customers have identified as important and it should do it well. You can ensure that by dedicating 80% of your efforts to improving existing features versus cranking out new ones.

Steve Blank bakes price exploration right into the initial customer interviews. Price, like everything else, is built on a set of hypotheses that needs to be tested early. Steve suggests you ask potential customers if they’d use the service for free. This is to gauge if the product’s value proposition is compelling at all. You then ask if they’d use the service for $X/yr. How do you come up X? You can simply roll the dice and adjust along the way, or use Neil Davidson’s excellent guide to software pricing to start with a more educated guess. Once your MVP is built, Steve asks you to sell it to your early customers. There is no clearer customer validation than a sale.

Sean Ellis, on the other hand, argues that achieving initial user gratification (product/market fit) is the first thing that matters and suggests keeping price out of the equation so as not to create unnecessary friction:

“I think that it is easier to evolve toward product/market fit without a business model in place (users are free to try everything without worrying about price). As soon as you have enough users saying they would be very disappointed without your product, then it is critical to quickly implement a business model. And it will be much easier to map the business model to user perceived value.”

Both Steve and Sean advocate removing price from the equation — but at different points. Steve removes price during the customer discovery process but suggests you charge for your MVP. Sean removes price from the MVP and suggests you charge after product/market fit. I can see the merits of both approaches and wondered which was right for my product: CloudFire: Photo and Video Sharing for Busy Parents.

Why not use freemium?

On the surface, freemium seems like the best of both worlds: Get users to try your service without worrying about price, then up-sell them into the right premium plan later. However, many people make the mistake of giving away too much under the free plan, which leads to low or no conversions. It’s human nature — we all want to be liked.

More important, we don’t yet have enough information to know how to price or segment the feature set. I made this mistake with my first product, BoxCloud: an early visionary customer called me up and said, “I really like your product and want to pay for it but your pricing doesn’t require it.” After a few more iterations of segmenting the feature set, I decided to forgo the free plan and simply offered premium plans with a trial period. Sales went up and so did the quality of feedback, which I attribute to the difference between feedback from customers versus users.

Lincoln Murphy just published a timely white paper on “The Reality of Freemium in SaaS” which covers many important aspects to weigh when considering Freemium, such as the concept of quid pro quo where even free users have to give something back. In services with high network effects, participation is enough. But most businesses don’t have high enough network effects and wrongly chase users versus customers. What I particularly liked in this paper is Lincoln’s recongition that “Freemium is a marketing tactic, not a business model.”

I strongly feel that, especially for SaaS products, starting with free and figuring out premium later (all too common) is backwards. If you know you are going to be charging for your product, start by validating if anyone will pay first. There is no better success metric and it leads to less waste in the long run. Focusing on the premium part of freemium first lets you really learn about your unique value proposition — the stuff that will get you paid. You can then come back and intelligently offer a free plan (if you still want to) with more intelligence and the right success metrics clearly defined. Even if you think you have a one-dimensional pricing plan like I did (e.g. number of projects), you’d be better served testing it with paying users because pricing experiments take a much bigger toll than other types of experiments.

Testing price in interviews

How did I put all this to test? The biggest mind shift in following a lean startup process is going from thinking you know something to testing everything you think you know.

So I followed Steve Blank’s advice and built some pricing questions into my initial face-to-face customer interviews. Because CloudFire is a re-segmented product in an existing market, potential customers referred to competitor pricing. This had to be balanced against the perceived value of our unique value proposition – saving time with faster and easier sharing of lots of photos and videos. Through these interviews I determined that, like their sharing needs, my potential customers valued simple hassle-free pricing and $49/year for unlimited photo and video sharing was a fair price they were willing to pay. That is what I charged them once my MVP was ready.

Testing price on the web

I wanted to run the same set of pricing tests with web visitors that I did during my interviews. Short of split testing a free and paid version of the MVP, which is technically illegal (update) and unfair to paying customers, I decided to split-test 3 different products with 3 different prices:

$49/yr for unlimited photo and video sharing

$24/yr for unlimited photo sharing

FREE for 500 photos

All plans have a 14-day free trial with the exception of the free plan which is free forever. Here are the variations I tested:

Original: Single unlimited plan

This is the simple option I discovered during customer discovery interviews. It served as the control.

Variation 2: Multiple plans

I segmented the product into 2 offerings: unlimited photos+video and unlimited photos only. I wanted to test price sensitivity and gauge interest in video sharing. Not many people I interviewed were currently taking lots of videos but they all wanted to be taking more.

Variation 3: Freemium

This has the 2 plans from above along with a limited free plan. Yes, this is a freemium plan. I wanted to measure if a limited free plan would disproportionately drive the right type of traffic (busy parents in my case).

Variation 4: No Price During Introductory Period

I added a fourth variation to test Sean Ellis’ advice on removing price till product/market fit, but I tested this differently. I was not comfortable offering the full product for a price and for free at the same time. So rather than including this page with my A/B tests, I instead tested it with new parents I interviewed.

The Results

First Place: The original single plan — second place in conversions and best overall performer. Surprisingly, the original page was the best overall performer.

Second Place:Variation 3: Freemium – most conversions but second place overall. Not surprisingly, the freemium variation drove the most conversions but only outperformed the original by 12% and had the lowest retention. Referral stats combined with random polling/emailing revealed a majority of the users that signed up were just curious (and not parents).

Non-starter: Variation 4: No price during introductory period. Parents I interviewed did not understand the introductory period without explanation and were reluctant to try the service without knowing how much the service was going to cost. Probing further, they weren’t willing to invest the time building up web galleries and inviting others only to find that the service might be priced out of their expectation.

What I learned

It does pay to align pricing with your overall positioning. Our unique value proposition is built around being “hassle-free and simple” and people seemed to expect that in the pricing model as well. A lot of our existing customers were already paying for their existing sharing service so the leap from free to paid was not a big one. While Sean suggests removing price before fit for consumer facing products, he suggests always charging for enterprise customers to gain their commitment. This is another case where pricing needs to be explicit. Using Cindy Alvarez’s model, our customers appear to be Time-Poor, Cash-Rich. Offering no-hassle free trials was sufficient to remove the commitment risk. Money back guarantees might be another way to further lower this risk.

The biggest lesson learned, though, is how accurate my initial customer interview findings were, compared to all the hypotheses that followed. Pricing is more art than science and your mileage will vary, but whenever possible get out of the building, talk to a customer, and consider testing price sooner rather than later.

What do you think? Why do you think these variations finished the way they did? What other variations would you like to see us try? How else do you think we could increase conversions? I’m looking forward to discussing your responses in the comments.

“The Web These Days · It’s like this: The time between having an idea and its public launch is measured in days not months, weeks not years. Same for each subsequent release cycle. Teams are small. Progress is iterative. No oceans are boiled, no monster requirements documents written.

“And what do you get? Facebook. Google. Twitter. Ravelry. Basecamp. TripIt. GitHub. And on and on and on.

The audience consisted of students from Steve Blank’s course on customer development. So you will hear an occasional remark from Steve or his students. When Eric refers to a “case”, he is talking about this Stanford GSB case about his company, IMVU, and his previous company, there.com.

Built to learn

Many founders believe that early stage startups are endeavors of execution. The customer is known, the product is known, and all we have to do is act.

Eric takes a different approach. He believes that many early stage startups are labors of learning. The customer is unknown, the product is unknown, and startups must be built to learn.

IMVU learned its way to product/market fit. They threw away their first product (40,000 lines of code that implemented an IM add-on) as they learned customers didn’t want it. They used customer development and agile software development to eventually discover customers who would pay for 3D animated chat software ($10M in revenue in 2007). IMVU learned to test their assumptions instead of executing them as if they were passed down from God.

Learning to learn

This is the scientific way of building startups. It requires a commitment to learning and thoughtfulness. It is being documented in books like Steve Blank’s Four Steps to the Epiphany and blogs like Eric Ries’ Startup Lessons Learned. It represents the triumph of learning, over the naive startup creation myths we read about in the media.

IMVU learned to learn. This process can be replicated at your company. Please do try this at home.

“[Recessions] can cause people to think more about the effective use of their assets. In the good times, you can get a bit careless or not focused as much on efficiency. In bad times, you’re forced to see if there is a technology [that will help].”

Water hides the rocks at the bottom of the ocean. Lowering the water level exposes the rocks underneath.

In a great economy, money hides problems and opportunities. Companies will get orders whether or not they innovate. But in a bad economy, lowering the water level will expose new opportunities to our corporations.

Reduced spending will spur businesses to create products that even newly poor customers will buy. Products that customers truly need and value. Products with enduring value.

“The Toyota production system was conceived and its implementation begun soon after World War II. But it did not begin to attract the attention of Japanese industry until the first oil crisis in the fall of 1973. Japanese managers, accustomed to inflation and a high growth rate, were suddenly confronted with zero growth and forced to handle production decreases. It was during this economic emergency that they first noticed the results Toyota was achieving with its relentless pursuit of the elimination of waste. They then began to tackle the problem of introducing the system into their own workplaces… Prior to the oil crisis, when I talked to people about Toyota’s manufacturing technology and production system, I found little interest.”

Ed: This is a guest post by Kevin Meyer, the President of Factory Strategies Group, which operates Superfactory. He also writes an excellent blog called Evolving Excellence. In this post, Kevin describes how American Apparel unwittingly applies lean practices like short cycle times (concept-to-product in 8 days), integrated QA, cross-functional teams, and more.

American Apparel has long been one of my favorite companies. I love companies that think outside the box, ignore popular wisdom, and, in doing so, teach us some lessons.

Brief background on why I like them so much: this is a $500 million manufacturer of t-shirts, underwear, and the like. Typically low margin products, the kind of thing that usually comes from Asian and Central American sweatshops.

But not at American Apparel. This company makes over 1 million articles of clothing per week, from their one factory in Los Angeles and they grew 40% this year. They pay their 5,000-person workforce significantly above minimum wage (average is $12-$15 per hour), give them full subsidized benefits (such as high quality health care insurance for $8 per week), and they turn a profit.

This should embarrass the heck out of any executive who thinks he has to outsource in order to find effective labor. Or at least call into question his fundamental competence as a leader. If American Apparel can manufacture low margin clothing efficiently enough to beat the sweatshops (in California no less), then anyone should be able to. If they try hard enough.

Apparently some of the brass at the company have kept tabs on my blog as, about a month ago, I got a phone call inviting me to come down for a visit. It was everything I expected, and more, and in many aspects it rivaled the various Japanese factories I visited recently.

First Impressions

One of those aspects was the first impression. When we arrived at Saishunkan in Japan, we were greeted by a gardener who turned out to be the chairwoman of the $270 million company. At another factory we walked in to see the president of a $100 million company on his knees scrubbing the floor.

When you arrive at American Apparel, you see several massive multi-story warehouse buildings. At the business address is an open entrance with an old table and a visitor sign-in sheet. That’s it. It’s on the lower left of building in the photo below. No, not the far left… that would be the company store. The open gap entrance just to the right of the store… which looks like any of the other roll-up dock doors.

No fancy lobby with glitzy lighting and display cases, no plush waiting rooms. An open entrance with a guard and a sign-in sheet. For a $500 million company with over 5,000 employees.

As you can tell from this photo and the others, the buildings aren’t in particularly great shape either. But they serve their purpose, and do it well. They may need a coat of paint, but they’re clean, neat, and filled with a lot of happy brains.

The people

The value at American Apparel isn’t created by the building, or the machines, but by the people. So many companies—probably the vast majority—think of their people as a cost. Very few companies recognize the value of the brain that sits slightly north of their people’s hands. American Apparel realizes that the value of that brain more than offsets the traditional cost difference between their employee’s hands and a pair of hands in a sweatshop.

What value has been added by the brains of their employees? How about this: their highest volume product, a “deep V” t-shirt, was the idea of one of their shop floor folks. Or this: American Apparel makes and sells a variety of unusual products, such as dog sweaters and baby bibs. Why? Because their employees figured out how to design those products with the little remaining scrap that exists after cutting out the patterns for the mainline products. There’s still some scrap left, so they had another idea: create a machine that would combine and weave it into bikini straps and cords for hoodies… like in the photo on the right. There’s still a tiny bit of scrap material left, so that is sent to a recycler, who turns it back into yarn and thread, which is then turned back into cloth for more products.

In fact, sustainability is a big deal to American Apparel. How many of you haven’t embarked on sustainability programs because of their cost? Well, American Apparel recycles just about everything, obtains 30% of its power from solar cells on the roof (and they are looking into getting much more), and many of their trucks run on biodiesel. They buy as much organic cotton as they can… domestic organic cotton—they believe that the carbon footprint created by sourcing organic cotton from overseas is too much of a negative offset. Anyone interested in growing more organic cotton in the U.S., here’s your customer. So once again, if you think sustainability is too expensive, then you should be embarrassed.

Workcenters

But let’s get back to the people. Production takes place on each floor of all of these buildings by multitudes of 4 to 8 person cells (they call them “workcenters”). A kit of cut cloth is wheeled to each cell and they crank through it. A chart of metrics is maintained at each cell. See the column on the right, which I know you can’t read? It’s dollars… and reflects the dollar value of what the cell has created, and most importantly the actual dollar portion that they get to share. A form of piecework on top of a nice base hourly rate. Each cell has a quality control person, and other quality people roam between the cells.

Do you see that they’re smiling? It’s no wonder; they are valued and treated very well. Not only do they have a doctor on site, they have a full modern clinic. Back when there was a transit strike in LA, the company bought a couple thousand bicycles and created a bike loan program, with free maintenance, that still exists. How many companies have purposely eliminated phones on their manufacturing floor to cut costs? American Apparel has phones all over the place, and provides free calls—even long distance. That’s a major benefit to their primarily immigrant workforce.

And perhaps most importantly, the company actively solicits their employee’s ideas and recommendations, and they actively implement them. It’s no wonder their retention rate is over 98%.

Vertical integration

A few more concepts.

How about the importance of gemba? Administration, marketing, design, and other offices are scattered throughout the buildings. They are not adjacent to each other. So everyone must walk through the factory floor multiple times a day. Everyone is continually aware that they are in a manufacturing facility.

Another concept: complete vertical integration. Everything is done at this cluster of buildings, with the exception of some dyeing that is done a few miles away. Design is done, often tested by Dov Charney himself, and sent to the factory floor. Time from raw concept to a finished product in over 200 stores worldwide? Eight days. Compare that to the weeks and months it can take to send a container across the ocean. Did the Olson Twins wear something unique yesterday? A new design can be created and placed into stores almost immediately to capitalize on the brief craze.

Complete advertising development, through photographing the models, to final printing, is also done at the factory. The props for all of the stores are created and sent from this factory. When a new store is opened, the fixtures and initial inventory are sent, often pre-hung on hangars so the new retail clerks can focus on selling.

Since everything is created in one factory, they can react fast, and therefore the stores don’t have to maintain as much inventory. Shipments, globally, are smaller and more frequent. They have a unique way to balance raw material inventory: if raw inventory gets too large, they simply create a new design that will consume that inventory and sell it. A luxury many of us wish we had.

Are you embarrassed yet?

I’ve previously written about Sun Hydraulics, a 1,000 employee, $170M company, with no job titles except “plant manager”… the guy in charge of watering the plants in the factory. American Apparel is very similar. Sure there is the CEO, there’s a marketing department, and there are cell leaders. But not much more. I asked a couple of my hosts what they did and I got answers like “some strategy stuff, but then I also figure out how to hire people for the stores.” Basically whatever needs to be done.

American Apparel may be very altruistic, but they still realize they’re a business. A business that has to make money to continue to provide the stable solid jobs for their valued workforce. My hosts told me about some other companies with similar values, who focused too heavily on the “communal good” and soon went out of business.

And yes, I saw Dov. He’s been in the news quite a bit recently, thanks to a workplace atmosphere that would make some cringe. At the risk of offending the more sensitive among us, part of me applauds his guts to run the company as he sees fit, traditional rules be damned. It even earned him a great spoof on Saturday Night Live. By any measure, he is a retail genius and he has the smarts to see outside of the “must outsource to make clothes” traditional mindset.

But here’s my final and perhaps most important lesson: do what works. It’s that simple. Tools, even lean tools, are just tools. Leadership requires people. At American Apparel there are no cheesy signs with “Teamwork” and “Challenge” on them. There are no glitzy glass lobbies. There is no sign of lean manufacturing in the traditional sense, and they don’t profess to be lean. No heavy lean training of employees, no overwhelming visual controls besides the metrics charts at the cells, no Shingo Prizes or Baldrige Awards.

But there are bunch of people recognized and compensated for their knowledge, creativity, ideas, and experience. A group of people who realize that speed creates value, knowledge creates ideas, ideas create profit. They figure out what works, then they do it exceptionally well.

A 5,000 person, $500 million low margin clothing company, operating from a single factory in the least business-friendly state of one of the highest “cost” manufacturing countries. Beating the overseas sweatshops and still growing rapidly.

The second step in my lean journey was a book called Extreme Programming Explained. It is dirt cheap (you can buy the first edition for a penny) and the entire book is accessible to non-programmers. If you buy it, try to get the first edition—the second edition isn’t as good as the first.

The subtitle of this book is “Embrace Change”—here are a few excerpts to whet your appetite…

The Driving Metaphor

“Driving is not about getting the car going in the right direction. Driving is about constantly paying attention, making a little correction this way, a little correction that way.

“Everything in software changes. The requirements change. The design changes. The business changes. The technology changes. The team changes. The team members change. The problem isn’t change, because change is going to happen; the problem, rather, is our inability to cope with change.”

What is XP?

“To some folks, XP seems like just good common sense. So why the “extreme” in the name? XP takes commonsense principles and practices to extreme levels.

If code reviews are good, we’ll review code all the time (pair programming).

If testing is good, everybody will test all the time (unit testing), even the customers (functional testing).

If design is good, we’ll make it part of everybody’s daily business (refactoring)…

If integration testing is important, then we’ll integrate and test several times a day (continuous integration).

If short iterations are good, we’ll make the iterations really, really short—seconds and minutes and hours, not weeks and months and years (the Planning Game).

“When I first articulate XP, I had the mental image of knobs on a control board. Each knob was a practice that from experience I knew worked well. I would turn the knobs up to 10 and see what happened. I was a little surprised to find that the whole package of practices was stable, predictable, and flexible.”

What XP promises

“To programmers, XP promises that they will be able to work on things that really matter, every day. They won’t have to face scary situations alone. They will be able to do everything in their power to make their system successful. They will make decisions that they can make best, and they won’t make decisions they aren’t best qualified to make.

“To customers and managers, XP promises that they will get the most possible value out of every programming week. Every few weeks they will be able to see concrete progress on goals they care about. They will be able to change the direction of the project in the middle of development without incurring exorbitant costs.”

If you’ve already read this book, please let us know how you liked it. And if you haven’t, what are you waiting for?

I just finished reading Certain to Win. It’s about the warfare strategy of John Boyd, as applied to business. In war, you build your team and dismantle the enemy. In business, you build your team, delight the customer, and incidentally dismantle the enemy.

You might know John Boyd as the OODA Loop guy. I never really “got” the OODA Loop so, based on Eric Ries’ recommendation, I read this book.

In a software startup, the OODA Loop looks like this: (1) Come up with an idea, (2) Code it, launch it, (3) Learn from usage data. Keep repeating the loop, each time using the Learnings to influence your next idea. This is the Idea-Code-Data loop.

This might seem abstract or too obvious to be useful, so here are some of my favorite passages from the book—they should fill in some of the puzzle.

On agility and playing chess with half the pieces:

“Go find the best chess player you can and offer to play for $1,000 under the following conditions:

Your opponent moves first

You move twice for every move of his or hers.

“In fact, you can even offer to give up some pieces, to make it more fair. You will find that, unless you are playing somebody at the grandmaster level, you can give up practically everything and still win. Keep the knights and maybe a rook.

“This is a graphic illustration of how the smaller side, using agility, can overcome a large disadvantage in numbers. Does it strike you as far-fetched and removed from what happens in the real world? Consider that Honda and Toyota can bring out a new model in roughly 2 years, with superb quality, while it still takes Detroit at least a year longer…

“The idea that operating at a quicker time pace than one’s opponent can product psychological effects offers a way out of the “bigger (or more expensive) is better” syndrome. An opponent who cannot make decisions to employ his forces effectively—his command and staff functions become paralyzed by bickering and bureaucracy, for example—is defeated before the engagement begins, no matter how many weapons sit in his inventory. In this way, one could truly achieve Sun Tzu’s goal of winning without fighting. [Ed: If you move fast enough, every enemy is effectively incompetent.]”

On shaping the market through agility:

“With a strategy this powerful, your aim is not to respond to but to create the market conditions that you want…

“Customers often want things because competitors have dangled them in their faces… such “discovery of customer wants” does not provide the basis for strategy; it represents a failure of strategy…

“The essence of Boyd’s strategy in business competition is to shape ourselves and the marketplace to improve our capacity… to survive on our terms—generally at the expense of our competitors.”

On planning and strategy:

“Strategy is merely a scheme for creating and managing plans…

“There is nothing wrong with planning… generate and discard many of them as you cycle within your OODA loops.”

On not following the rules:

“The Americans would be less dangerous if they had a regular army.” – British General Frederick Haldimand, Boston, 1776

On culture as a long-term competitive advantage:

“Herb Kelleher, chairman and recently retired CEO of Southwest Airlines, brags that competitors could copy the details of his sytem—direct (as opposed to hub-and-spoke) routings, no reserved seats or meals, one type of aircraft, etc.—but they couldn’t copy the culture, the vibrant esprit de corps, because “they can’t buy that.” So far his words have been prophetic, at least as far as the other US major airlines are concerned.”